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Chapter 22: Activity-Based Costing

Chapter Introduction​

Marie has been using traditional costing methods for her restaurant, but she's noticing something strange. "Some of my menu items seem very profitable, but when I look at everything—the time it takes to prepare, the complexity, the special equipment needed—I'm not sure the costs are accurate," she tells Monsieur Schneider. "Am I really making as much profit as I think?"

Monsieur Schneider explains that traditional costing methods may not accurately reflect the true cost of products or services, especially when overhead costs are significant. "Activity-based costing (ABC) allocates overhead costs based on the activities that actually drive those costs," he says. "Instead of using a single overhead rate, ABC uses multiple cost pools and cost drivers to more accurately assign costs. This gives you a much better picture of true profitability."

Activity-based costing (ABC) is a costing method that identifies activities in an organization and assigns the cost of each activity to all products and services according to the actual consumption by each. ABC recognizes that it is activities that cause costs, not products.

In Luxembourg, activity-based costing is valuable for SMEs because:

  • Many SMEs have significant overhead costs
  • Traditional costing may distort product costs
  • ABC provides more accurate cost information
  • Better cost information supports better decisions
  • ABC helps identify unprofitable products/services

This chapter teaches you how activity-based costing works, how to identify activities and cost drivers, how to calculate activity-based product costs, and how ABC compares to traditional costing. You'll also learn how to apply ABC in Luxembourg SMEs.

By the end of this chapter, you'll understand how to use activity-based costing to get more accurate cost information—just like Marie will learn to do for her restaurant's menu items.

Why It Matters​

Activity-based costing is important for businesses with significant overhead costs because:

  • Accurate Costing: Provides more accurate product/service costs
  • Better Decisions: Better cost information supports better decisions
  • Profitability Analysis: Identifies truly profitable and unprofitable products
  • Cost Management: Helps identify and manage activities that drive costs
  • Pricing: Supports more accurate pricing decisions

Luxembourg-Specific Importance:

  • Many SMEs have significant overhead
  • Traditional costing may not reflect true costs
  • ABC helps with pricing in competitive markets
  • Better cost information supports profitability
  • ABC helps identify cost reduction opportunities

Understanding activity-based costing helps you:

  • Get more accurate cost information
  • Make better pricing decisions
  • Identify profitable products/services
  • Manage costs more effectively
  • Improve profitability

Learning Objectives​

By the end of this chapter, you should be able to:

  1. Explain why and how activity-based costing is used
  2. Calculate activity-based product costs
  3. Compare and contrast traditional and activity-based costing systems
  4. Compare and contrast traditional and activity-based costing methods
  5. Explain and identify cost pools and cost drivers
  6. Understand Luxembourg SME activity-based costing applications